If one believes in what one read these days in financial newspaper it seems that apart from an ongoing crisis in Europe, the world economy now might be looking at recession as well. The pundits are predicting a recession based on a concept of correlation, which in simple term means a mutual relationship or connection between two things, between recession and US treasury bond yield* spread for the past 60 years of data.
Are we going to see Recession in 2022 ?
As on 25th March,2022 the yield spread, the difference between 10-year and 2-year treasury bond yield in US, is just 20 basis points away from turning negative whereas a year ago this difference was 140 Basis Points (BPS)^. Since the beginning of 2021 the 2-year bond yield, or the fall in bond prices, in US has gained 145 BPS to reach at 2.14% whereas the 10-year bond yield is at 2.36%.
Anticipating US Federal Reserve raising interest rate by 200 BPS in 2022 the bond market is already spooking people across the globe. As in the past 60 years when the yield spread had turned negative then 10 out of 13 times the recession ensued in next 12-24 months. So, does this mean that a global recession is imminent?
Well, that depends on how one interprets data. As Nobel Laureate Ronald H. Coase once said, “If one tortures the data long enough, it will confess to anything”. One who understands the nuance of statistics appreciates that correlation necessarily does not convey causality. In the context of recession and US treasury yield spread curve this means that although there exists a relation between the two, but it does not necessarily mean that one causes the other.
Even in the past 60 years the probability of ensuing recession, with yield spread turning negative, is at best 75% (10/13). What’s important is to understand how does one prepare for such an event instead of just worrying about same. Trying to time the entry and exit into an investment based on forecast of impending recession is not a long term sustainable exercise.
Are you prepared to face a recession ?
In terms of financial planning that means that try to protect your short term by keeping an emergency corpus in safest of the debt instruments. Emergency corpus is for situations when one has planned for everything and then want to cover for unforeseen situations. Additionally, buying adequate health and life insurance to mitigate risk is a well known strategy that one can implement.
One is advised to have these basics in place and then only invest into a mix of equity and debt instruments for long term based on one’s risk appetite. We are living in a Volatile, Uncertain, Complex and Ambiguous (VUCA) world and one has to realize same sooner or later. So instead of worrying about same its better to be prepared.
The world has seen many recessions before, and one will see many more in their lifetime. Just 2 years back the world saw a black swan event of global pandemic leading strict lockdown but the major and minor economies of the world with a concerted effort overcame the adversity of losing lives along with economic output. So try to control what you could.
Do remember that investment is an optimistic exercise and pessimism has no place in it so hope for the best but be prepared for the worst. So, roll with the punches and keep moving forward.
*Bond Yield = Return an investor will receive by holding the bond till maturity
^Basis Points (BPS) = 1/100th of 1%
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